An LBO Giant Goes "Back to Basics"

November 12, 2002

Thomas Hicks has been the buyout man with the golden touch since the mid-'80s, when he made a fortune buying, rehabbing, and reselling Dr Pepper and 7-Up. In 1989, with John Muse, the lanky 6-foot-3 Texan went on to found the Dallas-based leveraged buyout firm Hicks, Muse, Tate & Furst. It ascended rapidly to the top ranks of the business, earning a reputation as the best LBO shop west of Wall Street.

A big factor in the success was its signature strategy of buying companies in related businesses -- mostly in media, manufacturing, and food brands -- and merging them into more valuable properties that it then sold, mostly at a handsome profit for investors.

The firm took a wrong turn three years ago, Hicks admits, losing more than a $1 billion on ill-timed bets in telecoms ($883 million went down the drain on six domestic telecom deals and two European ventures), the Internet, and in Argentina. Though it returned about $3.5 billion to investors over the last two years as older investments matured, Hicks Muse's reputation took a big hit.

Now, Hicks says the firm is returning to its roots (see BW, 11/18/02, "LBOs: Embracing Barbarians at the Gate" [subscribers only]). He recently spoke with BusinessWeek Dallas Correspondent Stephanie Anderson Forest about what went wrong and how he plans to get the firm back on track. Edited excerpts of their conversation follow:

Q: The firm has hit quite a few rough patches. Tell me what happened.

A: The late '90s was a very unusual period for the public and private markets. Multiples peaked in '99 at almost nine times EBITDA [earnings before interest, taxes, depreciation, and amortization] in the private market. [Now they're six.] We had two choices. We could have all taken a year off and played golf -- which would have been a great idea in hindsight -- or [we could try] to find ways to make money in that environment. So we [got into] the rapidly growing telecom space, and that's where we got off-message.

The first two or three deals worked extremely well right away. We had bought convertible preferred securities that had very onerous terms [for the seller]. Short of the companies going bankrupt, [they] ensured low- to mid-20s returns. RCN (RCNC) more than doubled within the first few months. Teligent (TGNTQ) almost tripled. Globix (GBIXQ) was up 600% within 90 days. Rhythms NetConnections (RTHMQ) more than doubled.

It was a very brief period -- less than a year. [But] six months after that, the capital markets totally shut off to telecom. A lot of companies went bankrupt, including three or four we were in.

The fundamental issue is, [we] violated our principles. No. 1, we don't invest in capital-intensive businesses, and these are extraordinarily capital-intensive. Secondly, we were in a noncontrol position. When you control a company, you can take action, you can restructure, you can solve the problem.

Q: Hicks Muse also invested in some Internet companies, most of which soured. Can we talk about that?

A: Yes. The other off-message thing we did was to dabble in some of the earlier-stage Internet investments -- $5 million here, $10 million there. Altogether about $200 million. Before we even closed Fund V, we went to our investors and said, "This is so out of character that we are going to protect you on these investments." They're guaranteed to have at least a 20% return on that $200 million worth of investments.

Q: When did you realize you had gotten off-message?

A: In the summer of 2000, [we] collectively said, "Let's go back to basics." We've made a lot of money for investors in three areas: media, branded food, and basic component manufacturing. We went to our investors last spring and made our mea culpas. We're two years into a very strong return to basics.

Q: How are you doing that?

A: This is the stage in the cycle when private-equity firms do very well because prices are very cheap. We're following a disciplined approach in domains that we have a lot of expertise with. [Swift & Co., the meat business of] ConAgra (CAG) is a great example. It's a fundamentally strong business -- people are not going to stop eating meat. It has strong, stable cash flow. We're buying it for five times cash flow.

ConAgra gave us very attractive financing to enhance our returns. We have other branded-food platforms. Pinnacle [has] very stable brands like Vlasic pickles, the market leader. We have a contract to buy another pickle company. We've bought Swanson Frozen Food, which had gone into a real decline. It has turned around dramatically in the last six months.

Q: What happened with your investments in Latin America?

A: When you talk about Latin America, it's really Argentina. Our strategy has been to stay in fundamental infrastructure companies like cable TV, media. We have an independent cable company in Argentina called Teledigital that's very successful. We and John Malone's Liberty have 50% each of the largest cable company in Argentina, Cablevision. Our challenge is having [revenues in devalued pesos and] dollar-denominated debt, primarily in Cablevision but also in Claxson (XSON) [in which we're a part owner]. Both of those companies have to go through a restructuring.

We intend to be long-term investors, [but] our time horizon is going to be longer than [we thought it would be] when we first made the investment. If you own the largest cable-TV system in Argentina, at [some] point a global consolidator is going to want those assets, so we need to maximize our investment between now and that time.

Q: I understand that there were also some internal things that contributed to the firm's stumbles.

A: There are three points. One regards our Monday morning partners' meetings. When we went to open meetings [with all professional staff in 1999], the partners didn't feel as inclined to take each other on. We recognized that about a year into it and said, "Let's have open and closed meetings."

Second, [in the late '90s,] people were in a hurry throughout the investment community. We were no exception. We've slowed everything down and recommitted ourselves to doing totally sound, solid, due diligence before we make an investment. I think the due diligence now is probably the best we've had in 15 years.

Third, [in 2001] we formed a management committee that John [Muse], Jack [Furst], and I comprise today. Everybody on the committee has to sign off on every new deal. In the past, we had an informal understanding that we would all sign off. [But] as the firm grows, you need to have a formal body.

Q: So, what does all this mean for your fund returns?

A: Fund IV [the $1.6 billion fund that invested in telecoms] will be in the single digits. It will be the worst fund we've ever had, but it may end up being in the top half of the industry. It certainly was a disappointment for us.

Fund III is still in process. [Its internal rate of return] will be north of 20%. There were some great assets, including Clear Channel (CCU), in that portfolio. Clear Channel was actually in Funds II, III, and IV. We [gave] investors their money on Fund II.

Q: What about the first Latin American Fund?

A: I think it's too early to tell.

Q: And the European fund?

A: It will be consistent with our past performance: mid- to high-20s. In the European fund, we had a broadband loss. We've had losses in every fund that we've ever raised. That's the way this business works. But at the end, if you can generate a 25%, 30%, 35% return, you have a great asset class.

Q: Has it been difficult to regain investor trust and confidence?

A: Most of our investors stuck with us. We lost a few that were new investors in Fund IV, and I think we have to show everyone as we go forward in the next 25 years that that was blip on a long-term radar screen. Meanwhile, we've also returned about $3.5 billion to our limited partners over the last two years or so.

Q: Will we see the kinds of returns we saw in late '80s and early '90s?

A: Absolutely, at these prices. Unfortunately, a lot of limited partners jumped into private equity at the absolute worst time -- in '99 and 2000. Today is probably the most attractive time to be participating in the industry we've seen since 1990-91 -- and maybe the mid-'80s.